Negotiating Curves

If you feed-at-the-trough of the mainstream financial outlets, seldom does a day go by that you are not confronted with conjecture about whether the Federal Reserve will raise or lower rates.

Most of us simply lap this stuff up.

While it is not my intention to dismiss the importance of absolute [nominal] consumer interest rates [after all, many of us do have mortgages and credit cards], we might be better served by paying a little more attention to relative interest rates, and more specifically, the slope of the interest rate curve.

The following is snapshot of recent benchmark market interest rates [pay particular attention to the spread between 2 year and 10 year bonds]:

US Treasury Bond Yields On Selected Dates:
MaturityToday [Feb.25]Feb. 20Jan. 21
3 Month2.222.152.16
6 Month2.142.082.29
2 Year2.052.132.00
3 Year2.072.141.95
5 Year2.882.982.57
10 Year3.833.893.44
30 Year4.594.614.20

Over the past month we can clearly see that interest rates [as measured by the 10 year bond] have risen from 3.44% to 3.83%, a 39 basis point rise in 10 year rates.

What’s Going On Beneath the Surface

Instead of simply looking at what has happened to 10 year rates in isolation, let’s consider what has happened to the 2 year – 10 year interest rate spread:

Jan. 21 [3.44-2.00] = 1.44; Feb. 20 [3.89-2.13] = 1.76; Feb. 25 [3.83-2.05] = 1.78

In bond market parlance, the progression outlined above is referred to as “curve steepening”:

Folks should understand that a steepened yield curve typically does not happen by accident.

Given our current financial climate, this might be seen as a clearly orchestrated move on the part of monetary authorities to allow banks to fatten their profits [by raising - borrowing - short term funds to lend longer term ‘risk free’ to the government] at public expense to help the banks repair their battered balance sheets.

There are some market observers who would describe this change of slope in the interest rate curve as the ‘socialization’ of bank losses.

Whether this is truly the case or not – the slope of the interest rate curve:

[historically] is used as a predictor of growth, inflation, and future interest rates, and it is often taken as an indicator of the stance of monetary policy. A positively sloped yield curve has been associated with an increase in output in the period ahead, and with an increase in future inflation and short-term interest rates. A negatively sloped, or "inverted," yield curve has been taken as an indicator of future declines in these variables.

So, by being alert to changes in the slope of the interest rate curve, we may gain insightful hints as to what lies ahead in terms of output, economic activity, and perhaps even the near term prospects of our equity portfolios.

Today’s Market

Overseas equity markets began the week on a very positive note with Japan’s Nikkei Index up 414 to 13,914. North American markets also began the week with strong advances. The DOW was ahead by 189.20 to 12,570.20, the NASDAQ gained 24.13 to 2,327.48 and the S & P added 18.65 to 1,371.75. NYMEX crude oil futures gained .42 to finish the day at 99.23 per barrel.

On foreign exchange markets the U.S. Dollar Index lost .02 to end the day at 75.50.

Interest rates were modestly higher with the benchmark 5 yr. government bond ending the day at 2.96% while the 10 yr. bond ended the day at 3.90%.

Precious metals ended the day mixed with COMEX gold futures losing 5.40 to 940.00 per ounce while COMEX silver futures ended the day up .06 at 18.08 per ounce. The XAU added .41 to 190.35 while the HUI climbed 1.64 to 466.37.

On tap for tomorrow, at 8:30 a.m. Jan. PPI data is due. Headline expected +.4 vs. prior -.3. Core PPI expected unchanged at +.2 vs. prior +.2. At 10:00 a.m. Feb. Consumer Confidence data is due, expected 80.0 vs. prior 87.9.

Wishing you all a pleasant evening and bountiful investment returns!

About the Author

rkirby [at] kirbyanalytics [dot] com ()
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